posted by Nicole on .
Bernie and Pam Britten are a young married couple beginning careers and establishing a household. They will each make about $50,000 next year and will have accumulated about $40,000 to invest. They now rent an apartment but are considering purchasing a condominium for $100,000. If they do, a down payment of $10,000 will be required.
They have discussed their situation with Lew McCarthy, an investment advisor and personal friend, and he has recommended the following investments:
The condominium - expected annual increase in market value = 5%.
Municipal bonds - expected annual yield = 5%.
High-yield corporate stocks - expected dividend yield = 8%.
Savings account in a commercial bank-expected annual yield = 3%.
High-growth common stocks - expected annual increase in market value = 10%; expected dividend yield = 0.
Calculate the after-tax yields on the foregoing investments, assuming the Brittens have a 28% marginal tax rate (based on Public Law 108-27, The Jobs and Growth Tax Relief Reconciliation Act of 2003).
How would you recommend the Brittens invest their $40,000? Explain your answer.
Buying the condo requires borrowing money: What is the interest rate they would have to borrow on? Wouldn't that make a great difference, a loan of say one percent vs a loan of ten percent?
What are their family plans...do they have children coming on their minds?
(along with this...what are the restrictions on the condo...family, resale, subleting...etc)
Financial planning is not easy. Investing in a home is financial security issue as well as a financial investment issue.
Have you calculated the after-tax yields on the proposed investments? That's the place to start.
As you think about what to recommend for the $40,000 investment, remember that after they pay a down payment on a condo of $10,000, they'll only have $30,000 left to invest. I'd still recommend buying the condo, if the mortgage payments, association fees, and utilities come to 30% or less of their take-home pay.
They should also keep a substantial amount -- at least $10,000 -- in liquid funds like a savings account. Since they're young, I suggest they put $10,000 in common stocks, realizing they could lose a substantial portion of it in the short term -- and depending upon their investments -- the long term, as well.